How to Invest in SWP (Systematic Withdrawal Plan)?

SWP: A Complete Guide for Investors

Generating a steady stream of income from your investments is as important as growing your wealth. A Systematic Withdrawal Plan or SWP is a smart feature designed to provide you with a regular source of income from your accumulated corpus. It provides financial freedom and allows you to structure your cash flow according to your specific needs without liquidating your entire portfolio at once.

What is SWP?

Systematic Withdrawal Plan (SWP) is a facility that allows you to withdraw a fixed amount of money from your mutual fund investment at regular intervals. To put it simply, it is the exact opposite of a Systematic Investment Plan (SIP). 

While a SIP allows you to invest systematically to build a corpus, an SWP allows you to withdraw systematically from an existing corpus. It gives you control over the amount and frequency of the cash flow you receive.

How SWP in Mutual Funds Works?

As an investor, you need to understand how SWP in mutual funds work to use it effectively. When you set up an SWP, you instruct the fund house to redeem a specific number of units that match your desired withdrawal amount. The fund house sells these units at the prevailing Net Asset Value (NAV) on the specified date. The proceeds are then credited directly to your registered bank account. This process repeats automatically at the frequency of your choice.

Difference Between Withdrawing a Lump Sum vs. SWP

There is a significant difference between withdrawing a lump sum and using an SWP. When you withdraw a large lump sum, you might exit the market at an unfavourable time or deplete your capital too quickly. 

An SWP, on the other hand, enforces discipline by limiting your withdrawals to a fixed sum. It ensures that the rest of your money remains invested and continues to generate returns.

How Does an SWP Work?

Now that you know what SWP is, let us explore its workings in detail. Here is a step-by-step guide that can make the concept easy to understand. 

• Step 1: Make a lump-sum investment 

As an investor, you need to know how to invest for a SWP. Ideally, you must invest a significant lump sum amount into a mutual fund scheme of your choice and allow it to grow in size. After a few years, the accumulated corpus serves as the source from which future withdrawals will be made.

• Step 2: Choose the Withdrawal Amount 

When opting for a Systematic Withdrawal Plan, you must decide the exact amount you wish to receive in your bank account. It is advisable to calculate this based on your monthly expenses or the income gap you need to bridge.

• Step 3: Select Frequency 

SWPs provide the flexibility to choose how often you want the payout. For example, you can select the monthly withdrawal option for managing regular household expenses or the quarterly option if your needs are less frequent.

• Step 4: Units are Redeemed Systematically 

On the chosen date, the mutual fund house calculates how many units at the prevailing Net Asset Value (NAV) match your withdrawal amount. They then redeem these units from your folio and transfer the proceeds to your bank.

• Step 5: Remaining Units Continue to Grow 

The units that are not sold remain with you and continue to benefit from market movements and generate returns on the balance corpus.

Note: When deciding to invest for a SWP, you can also opt for a Systematic Investment Plan instead of a lump sum investment. However, it is important to note that building a large-enough corpus using an SIP takes a long time compared to the lump sum option.    

How to Invest for a SWP – Step-by-Step Process

Many investors struggle with the execution part of setting up a Systematic Withdrawal Plan. Here are a few critical steps that you must follow carefully.

• Step 1: Choose the Right Mutual Fund 

When you invest for a SWP, you should select a fund that aligns with your risk appetite. Conservative investors typically prefer debt funds or hybrid funds as they have lower volatility. Aggressive investors often prefer to invest in pure equity funds. 

• Step 2: Decide the Lump-Sum Investment Amount 

It is essential to ensure your initial corpus is large enough to support your withdrawals. A small corpus with high withdrawals will deplete rapidly and leave you with zero balance. 

• Step 3: Select Withdrawal Amount 

Determine a withdrawal amount that is lower than the expected return of the fund. If you withdraw more than the fund earns, you will deplete your principal capital very quickly. 

• Step 4: Choose Withdrawal Frequency 

Select a frequency that matches your cash flow requirements. Most investors choose the monthly option as it mimics the regularity of a salary or pension credit.

• Step 5: Start SWP and Monitor Performance 

After you submit the request for SWP in mutual funds and the payouts begin, you must review the fund balance annually to ensure your plan remains on track.

Who Should Opt for SWP?

You should opt for SWP only if your financial profile and goals match the specific utility of this product. Here are some categories of investors who may invest for a SWP. 

• Retirees Needing Regular Income 

If you have retired and have a lump sum retirement corpus, SWP is ideal for you. It serves as a substitute for salaries or pensions and provides money for daily living expenses.

• Investors Using SWP for Expense Management 

If you have irregular income from your profession or business, you can use SWP to smooth out your cash flows. It provides an additional source of income to cover fixed monthly obligations.

• Tax-Efficient Withdrawal Seekers 

SWP taxation is more efficient compared to traditional interest income because you pay tax only on the capital gains component.

• Investors Shifting from Growth to Income Phase 

If you have spent years building wealth and now want to enjoy it, SWP help you transition. It allows you to use your wealth systematically without liquidating everything at once.

Benefits of Investing in SWP

Here are a few compelling reasons why smart investors prefer SWP in mutual funds over traditional fixed-income products. 

• Regular Income Stream 

SWP ensures that you get a fixed amount in your bank account regularly. The predictability helps you budget your household finances and pay bills on time.

• Better Tax Efficiency Than Dividends 

Mutual fund dividends are taxed at your slab rate, which can be very high. In contrast, SWP returns are treated as capital gains, where only the profit portion is taxed.

• Flexibility in Withdrawal Amount 

You are not stuck with fixed SWP returns for life. In fact, you can increase or decrease the withdrawal amount anytime to adjust for inflation or changing financial needs.

• Potential for capital appreciation 

Since a portion of your money remains invested, it has the potential to grow further despite the withdrawals if the market performs well.

Risks and Limitations of SWP

Ignoring the risks associated with SWP in mutual funds can lead to premature depletion of your hard-earned savings.

• Market Volatility Risk 

If the market crashes, the NAV of your fund falls. To generate the fixed withdrawal amount, the fund house will have to sell more units. This accelerates the reduction of your unit balance.

• Risk of Capital Erosion 

If your withdrawal rate exceeds the return rate of the fund, your principal amount will shrink within a short period of time.

• Poor Fund Selection 

If you choose a consistently underperforming fund, your capital will deplete faster. You must ensure the underlying fund has a track record of stability and reasonable returns.

• Inflation Risk 

A fixed withdrawal amount today might not be sufficient five years later due to inflation. You might need to increase your SWP returns, which leads to faster corpus reduction.

SWP vs. SIP vs. Dividend Option

The table below outlines the differences between dividends, SWP and SIP in detail.

SWP Taxation

SWP taxation is generally more favourable compared to traditional fixed-income instruments.

Every SWP payout consists of two parts - the principal investment and the capital gain. You only pay tax on the capital gain portion and not on the principal amount. This means your tax outflow is very low compared to the tax on FD interest.

For equity funds held for more than 12 months, Long-Term Capital Gains (LTCG) above Rs. 1.25 lakh per financial year are taxed at 12.5%. If you withdraw from equity funds within 12 months of investment, you pay 20% Short Term Capital Gains (STCG) tax. Holding for longer periods significantly reduces your tax liability on the withdrawals.

For debt funds, the capital gains are taxed according to your income tax slab, irrespective of holding period.

How Much Can You Withdraw Through SWP?

In a bull market, your corpus might grow fast enough to support higher SWP returns. In a bear market, you might need to reduce withdrawals to protect your capital from erosion.

Financial experts often recommend a withdrawal rate of 4% to 6% annually. This rate generally ensures that your corpus survives for a long period, even during market downturns. Meanwhile, if you withdraw 10% or 12% annually, you risk depleting your capital within a decade. 

Common Mistakes to Avoid While Opting for SWP

It is important to avoid these common pitfalls when opting for SWP in mutual funds.

• Do not set a high withdrawal amount, as it is the quickest way to exhaust your savings.
• Avoid staying invested in a fund that consistently underperforms its benchmark. If the fund does not grow, your SWP will reduce the principal faster than planned.
• Do not rely solely on volatile small-cap funds for regular income. A balanced mix of equity and debt provides the stability required for reliable SWP returns.
• Do not forget to review your SWP periodically. Reviewing the plan annually lets you adjust for inflation, tax changes and fund performance.

FAQs on SWP

• Is SWP safe? 

Although SWP is relatively safe if you choose the right mutual fund and maintain a conservative withdrawal rate, it is still subject to market risks and volatility.

• Can SWP run for a lifetime? 

SWP in mutual funds can run for your entire lifetime, provided your withdrawal rate is lower than the fund's growth rate, and the corpus is sufficiently large.

• Is SWP better than FD? 

SWP in mutual funds is generally more tax-efficient and offers better potential returns than FDs. However, FDs offer guaranteed capital safety, which SWP does not.

• Can I stop or modify an SWP? 

Yes, you have complete flexibility to stop, pause or modify the SWP amount and frequency at any time.

• How often should I review SWP? 

You should review your SWP performance and the remaining corpus balance at least once a year to ensure it remains sustainable.

Conclusion

Mastering how to invest for a SWP empowers you to take control of your post-retirement cash flow. SWP in mutual funds helps transform your accumulated wealth into a reliable source of income that supports your lifestyle while keeping your remaining capital active in the market.

By choosing the right fund and a sustainable withdrawal rate, you can enjoy financial independence without the fear of outliving your savings.